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BoE Interest Rate Decision and Market Prediction

BoE Interest Rate Decision and Market Prediction

Mixed UK data increased the doubts of the BoE’s next monetary policy decision and its impact on the UK Economy.

An article published on Bloomberg last week by Greg Ritchie and James Hirai was notable.

“U.K. Rates Market Signals Any BOE Hikes May Be Short-Lived”

“The U.K. rates market is signaling that the Bank of England may have to rapidly undo any policy tightening it delivers over the next year and a half.

Inverted curves occur when shorter-term rates climb above longer-term ones, which is interpreted by some as a sign of an impending economic slump. This was seen in the sterling overnight index swaps curve, which saw an accelerated repricing this week to bet on about 110 basis points of rate hikes over the next year. That would take the BOE rate to around 1.20% by the end of next year.

Yet traders are wagering that the increases will peak in 12 to 18 months, and will soon be followed by a series of cuts to bring the key rate back below 1% by 2025.

The inversion indicates doubts that the BOE will be able to maintain the rapid rate hikes that traders expect it to deliver, especially with the nascent U.K. economic recovery likely to be threatened if both fiscal and monetary support are withdrawn simultaneously.”

The weekly closing of GBPUSD was also interesting and showed signs of fear.

Bloomberg reported: “Traders Start to Doubt the U.K. Rate Hikes They Just Predicted”

U.K. traders are starting to back-pedal after piling on bets that the Bank of England will raise rates this year.

While wagers for increases over the next year have been ramped up to more than 100 basis points, concerns over that pace of tightening are now surfacing in various corners of the market. Pound traders have not pushed the currency higher and interest-rate swaps signal any tightening may be soon followed by easing.

All these are signs of fear that rate hikes could be a mistake that squeezes consumers, amid a heady mix of threats to the Brexit deal, surging Covid cases, and sky-high energy prices. This backdrop sets the stage for November’s rate decision — one that Chief Economist Huw Pill called “finely balanced.”

“Markets are pricing that the BOE will not be able to raise rates a lot, signaling that the forthcoming hikes will cool inflation and also the economy,” said Bob Stoutjesdik, a fund manager at Robeco Institutional Asset Management. “You can label that perhaps as a policy error being priced.”

Here’s a look at some of the ways investors are casting doubt over how high rates could go:

Pound Confounds
Sterling has broken its link with bond yields, holding below $1.40 for a fourth month even as two-year rates surged to the highest since May 2019. Higher rates have supported the currency in the past, yet investors are now fumbling over what it all means for the pound.

The following revision is also important. Strategists surveyed by Bloomberg have downgraded their median year-end forecast to $1.37, down from as high as $1.43 four months ago.

The market’s proxy for the future level of BOE interest rates — the sterling overnight index swaps curve — is also casting doubt over the longevity of any policy tightening. It’s signaling that the key rate will peak at around 1.15% in 18 months, only to fall back toward 1% by the end of 2024. That has resulted in an inverted curve, which is interpreted by some as a sign of an impending economic slump.

Money-market prices for the next year or so have consistently moved further and faster than economists’ expectations for BOE tightening. Part of this reflects the slowness of analysts to react relative to traders, but also to how accurate a relatively illiquid swaps market is as a gauge of investor expectations.

Referring to Bloomberg’s Survey median year-end forecast of GBPUSD, 1.37000 was the weekly closing of the cable.

Although a possible rate hike may carry the price over 1.40, we will be targeting 1.36-1.34 range by the end of 2022.

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